Trying to get your head around the idea of freemium? Just think cloud storage service Dropbox and note-taking and archiving application Evernote, both of which have been phenomenally successful.
The word ‘freemium’ combines the two aspects of the business model: ‘free’ and ’premium‘. It’s a business model that works by offering a basic product or service free of charge (typically software, content, games, web services), and a fancier version that costs money. Fancy can mean more features, more functionality, more space, more usage, more seats, more time, or no advertisements.
The business model was first defined by prominent New York-based venture capitalist and blogger Fred Wilson in 2006: “Give your service away for free, possibly ad supported but maybe not, acquire a lot of customers very efficiently through word of mouth, referral networks, organic search marketing, etc, then offer premium priced value added services or an enhanced version of your service to your customer base.”
Wilson offers these examples:
- Skype – basic in network voice is free. Voice mail and calling plans that allow users to dial landline phones require a monthly fee.
- Flickr – a handful of pictures a month is free, heavy users convert to Pro
- LinkedIn – reeled in users with free content, but has boosted sales by adding features that customers have to pay for, such as recruitment services.
Wilson points out that this business model has been around for a long time. Shareware always used a similar model, and many successful software companies have been built on it. The customer is only a click away and if you can convert them without forcing them into a price/value decision you can build a customer base fairly rapidly and efficiently.
Wilson points out that it’s important to ask as little as possible in the initial customer acquisition process. Asking for a credit card even though you won’t charge anything to it is not a good idea. Nor is forced registration. You may want to do some of this once you’ve acquired the customer, but not in the initial interaction.
He offers this advice: “Don’t require any downloads to start. Don’t require plugins. Support every browser with any material market share. Make sure your service works on various flavours of Windows, OSX, and Linux. In short, eliminate all barriers to the initial customer acquisition.
And make sure that whatever the customer gets day one for free, they are always going to get for free. Nothing is more irritating to a potential customer than a ‘bait and switch’ or a retrade of the value proposition.”
The big idea is to make sure your free service is loved by customers. Only then do you communicate the value that comes with the paid service and that will have you converting to paying users.
The best examples of this business model are when the customer understands why the paid service has to cost money. More storage costs for photos, virtual storage, or termination costs on other carrier networks in the Skype model, are good examples.
What you gain on the swings
Much has been written about the psychology of free. Among the most instructive texts are Free: The Future of a Radical Price by Chris Anderson and Predictably Irrational by Dan Ariely. Both authors note that free immediately reduces the mental barriers for the customer.
Free makes people think that they have “nothing to lose.” That makes free a huge accelerator of adoption. The flip side of this is that after using the product for free, it is very hard to get the customer to start paying for it. This is why it is so critical to choose your premium features wisely.
But is it for you?
Freemium expert Uzi Shmilovici, CEO and founder of Future Simple, which creates online software for small businesses, cautions that before you think free (or rather freemium) is the best model for your business, you need to answer a few difficult questions:
- How big do I want my company to be? If you are looking to build a lifestyle business that’ll make you R80 000 a month and you have a good product, you can probably do without freemium. If you want to build a dominant company that has a substantial market share, Freemium can help you accelerate adoption.
- What is the value of the free users? Across all successful freemium companies, there is a way of making money or saving money from the free users. Either by saving on marketing costs (Dropbox) or by making money from ads or data (Pandora, Evernote, Mint) or both. Figure out how to turn your free users into savings in marketing costs or revenues from third parties.
- What is the cost to serve free users? This is a critical aspect of the model. If you spend a lot of money or time servicing free users, you are going to lose money. The cost of servicing free users must be lower than the rand value they provide.
- How big is my market? “The easiest way to get one million people paying is to get one billion people using,” says Phil Libin, the CEO of Evernote. Free adds another conversion step on your way to revenues. You need a big market to have enough people who will pay you at the end of the day.
- Is there value to one customer from other customers using the product? This will determine how many new users the free users will refer. There are three levels of value:
- Inherent value – You can use Skype only if the person you talk to uses it. The same is true of Dropbox. In this case, freemium can be a powerful strategy.
- Added value – You derive the value of Linkedin from other people using it. In this case, freemium can help you gain traction if you use an effective invitation mechanism.
- No value – You don’t care if someone is using Evernote or not. The only reason to tell another about the product or service is if they think it’s awesome.
Freemium and your business
Still wondering whether you can use freemium to your business’s advantage? Writing on Freemium Blog, freemium business model expert Peter Froberg has isolated a few characteristics of freemium success:
Quality free products
The most important condition for creating a successful freemium model is that you have a great product that people want. It will be the engine that drives your freemium-based business. Without inherent value your freemium will not get off the ground.
So instead of giving away a sample track of the music, let people download the whole album. Instead of letting people take a look at your worksheets, let them have all your tools for free.
Only a small percentage of free users will usually buy something. In order for this to make financial sense, the expense of distributing the free product should be very minimal. Digital duplication ensures virtually no cost for copying and distribution. If you want to distribute one million pieces of something, R1 as a unit price is quite a substantial amount.
Freemium depends on generating attention with the free product; then to sell premium products or services to some of the free users. In most cases only a small percentage of the free users will buy something. This is fine if it is a small percentage of a large number.
Creating a successful business
Froberg says his research has shown that there are two methods that should be incorporated to ensure freemium success:
Adapting the business model
If your free product is a quality product that people want, it will generate attention. You need complementary products to generate revenue from this attention.
Ensuring a wide distribution
The economic logic behind freemium is that, “When the supply of a product increases, the demand for its complementary products also increases.” The free product drives off the revenue-creating products and more free users means more paying users. Since additional distribution of a free product costs close to nothing, the success of a freemium business will increase with the number of people using it.
Helping This Along
- Actively promote the product
Making sure that more people get to know about it will lead to more users.
The generous nature of freemium fits very well with the emerging field of social media, and social media marketing has proved to be a good way of promoting a freemium product.
- Remove barriers for people to access the product
If it is hard to access your free product, some people will stop before they get to it. Not only will these people not be exposed to your thoughts, they will also have wasted time.
The cost of customer acquisition
Some people argue that freemium significantly increases the customer acquisition cost. The argument is that it costs money to acquire every new user, while only a few end up paying. Shmilovici says it’s important to consider what happens to the total amount of premium users in the case of freemium.
The total amount of premium users depends on three factors:
- Traffic – the amount of people visiting your site. People like to recommend them to their friends. With a freemium model, you will most certainly see an increase in traffic for the same marketing spend, since people will spread the word. You can further enhance the social media benefit by giving people easy ways to share their excitement and implementing a smart referral programme.
- Sign-up conversion – how many of them sign up. It’s likely that you’ll increase your conversion to users with a free offering, since users don’t need to enter their credit card details up-front. Unlike limited trial periods, your users don’t have to worry that their trial will end before they have a chance to try the product. Also, “Zero is a hot emotional button,” as Dan Ariely mentions in his book Predictably Irrational.
- Premium conversion – how many of those who signed up become paying members. Conversion to premium may drop since you might get a higher proportion of low-quality sign-ups. However, this is not the only factor at work. With freemium, people have a chance to use the product long enough to see the value in upgrading. At the same time, while they are using the free product, they build up switching costs. Eventually, they might be more likely to pay. Here’s Evernote CEO Phil Libin’s approach to this subject: “We’ve got the rest of your life to make money off you.”
To succeed in freemium, you need the increases in traffic and sign-up conversion to compensate for the drop in premium conversion rate, if any. In successful freemium companies, the boost to traffic and adoption significantly reduced the customer acquisition cost, which in turn led to great results.
SA’s first freemium HR and payroll software for business
Control your HR and payroll costs with free software that lets you choose additional premium functionality,
on a pay-as-you-use basis.
In September last year, employee management software developer PeoplePlus released the first HR and payroll software built on the freemium model in South Africa. Since then, almost 2 000 users have registered, with an additional 300 signing up every month.
“The cost of developing the software was high, but the cost of distributing it to users is relatively low,” says Rodney de Villiers, CEO of PeoplePlus. “We offer modules, such as disciplinary procedures and the ability to print payslips free. Users pay only for premium modules, and for what they use. There are no contracts, no big upfront payments, and no expensive consultants.”
De Villiers says the freemium model has been used widely for consumers, but less so in business applications. “The offering enables the business customer to select any high-value or efficiency functionality, in a modular manner. That means they can directly control their costs.”
The PeoplePlus offering is targeted at businesses with between one and 200 employees, but companies of all sizes can use the application.
Benefits for users include the sizeable reduction of the total cost of funding and operating your HR and Payroll IT, such as power, security, updates, back-ups, anti-virus, lost data, stolen equipment, staffing and consultants, not to mention your time and stress.
When it comes to support for free users, De Villiers says telephone support is offered as a premium service. “The application is easy to use, and comes with a number of practical ‘how to’ guides. If users need support, they’ll only pay for it when they want it.”
PeoplePlus was developed by Talenger Holdings, a company that De Villiers launched in 1998, and which specialises in human resource technology for large businesses. “PeoplePlus is basically a scaled-down version of the proven solutions that Talenger has been developing for years.
We analysed the local market and saw that more than 90% of businesses employ up to 200 people. That was how we identified a gap in the market for PeoplePlus. The freemium model has been proven and we are confident that the application will become increasingly popular because of its pricing and functionality.”
For more information, visit www.peopleplus.co.za
How freemium is changing industries.
In recent years, several industries have applied the freemium model with great success. This is particularly true in music and publishing. A great example is the rock band Nine Inch Nails. Fans could download their latest album Ghost l-lV for free and buy a range of other products from the extended $5 download, to a $300 limited deluxe boxed CD.
Flat World Knowledge is a company that publishes university textbooks. Where it differs from competitors is in its business model. Instead of only selling expensive paper versions that change every two years, Flat World Knowledge releases the books online for free download. Students and professors have access to quality textbooks at no cost.
The publisher makes money from selling a range of other products, such as a printed textbook, audio books, e-book for a device, individual chapters to print, or study aids.
Free-to-play online games, often overlooked in the hype around social and casual games, are growing just as fast as their counterparts. Much of this has to do with the industry’s transition from paid to freemium models – not only in online gaming, but for web and mobile apps on the whole.
Free: The Future of a Radical
Price, by Chris Anderson
Freemium Blog: www.freemium.org
Predictably Irrational: The Hidden Forces that Shape our Decisions, by Dan Ariely
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